In 2007, I learned firsthand what the word “recession” means. My business was booming, clients were coming to me left and right. My profit margins were great, and everything looked awesome…and then one day, it all disappeared.

Economies are cyclical. There are times when everything is good, and then there are times when jobs disappear, belts tighten, and people make do with what they have.

As investors, we need a strategy that is adaptive to changing marketing conditions. We need a strategy that will allow us to sleep at night. Taking this as a pre-requisite, here are some general rules of thumb to help you protect your portfolio:

•  #1: Have an investment policy statement in place. According to DALBAR’s annual Quantitative Analysis of Investor Behavior report, the “average” investor consistently underperforms the market. The reason is that investors’ emotions work against them. They end up buying high and selling low.

An investment policy statement helps remove the emotion from investing. It lays out when to buy, when to sell, and how to manage your portfolio.

Of course, you want your Investment Policy to be based on evidence, not emotion.

•  #2: Use actively managed exchange-traded funds (ETFs). Actively managed ETFs may invest in companies that are fundamentally sound rather than buying the entire market. While your positions might take a hit during a recession, at least stocks you hold via these ETFs can stand a better chance of making a quicker recovery or even profiting during recessions.

•  #3: Maintain a portion of your portfolio to investment-grade bonds. These high-quality fixed-income securities are less volatile than lower-rated junk bonds. Junk bonds can be just as volatile as stocks during bear markets. You want your bonds to provide safety not added volatility.
  
• #4: Track Your Correlations: be sure your positions are not highly correlated with each other. If you own stocks from the same sector, that is a significant risk.
• #5: Increase liquidity as your time horizon declines. Generally, the closer you are to retirement, the more “safe” assets you want to own—like a short-term bond fund or an aggregate bond fund instead of stocks. There are plenty of “rules of thumb” when it comes to what ratio to use. My recommendation, use a ratio that provides a volatility level you are comfortable with…this is where doing that historical return analysis helps. Another way to think about it is as a hedge. What percentage of the market’s movement would you like to experience? 60%, 70%, etc..

• #6: Take advantage of structured products. This investment type is not easily accessible, but your advisor might have access to them through institutional relationships. Essentially, a structured product allows you to swap the market’s upside for predetermined protection such as a high yield or a limit on the maximum downside of an investment. Sort of like how insurance products work, but without the same lock-up periods and generally more upside.
• #7: Stress-test your portfolio. Here’s a good method to stress test your stocks. Take your top five or ten holdings, then research their returns during the dot-com crash in 2000-02 and the Great Recession from 2007-09. Those recessionary periods can give you a good sense of how they might perform should the markets get worse - as some experts are predicting.

Remember, all the investment strategies in the world won’t help if they keep you up at night. Make sure that whatever strategy you are using it is designed for your confidence and peace of mind.

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